sealPurdue News
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June 1995

Venture capital-backed investments always risky business

WEST LAFAYETTE, Ind. -- There's an adage in the business world that the longer you're in business, the more bullet-proof you become.

But when it comes to businesses backed by venture capital firms, the adage becomes just another business myth, says a Purdue University expert. Lassaad A. Turki, assistant professor of management in Purdue's Krannert Graduate School of Management, says a 5-year-old business backed by venture capital is just as likely to fail as it was when it first opened.

"In these types of businesses, the risk of failure for a new company doesn't decrease as the company matures," he says. "As a business expands and moves into new levels, there are constant opportunities for things to go wrong. You're never out from under the gun."

In a recent study, "New Ventures: How Risky Are They?" published in the Journal of Small Business Finance, Turki and Robert H. Keeley, a professor at the University of Colorado at Colorado Springs, looked at 203 companies in the portfolios of three venture capital firms -- firms that invest in business activities that develop radically new products or enter unproven markets -- to determine the evolution of risk in young companies. Turki says that according to estimates, venture capitalists nationwide invested in more than 200 start-ups per year between 1981 and 1988.

The study identified five stages new ventures typically pass through before they become publicly held companies or are closed:

I. Seed -- feasibility testing stage. This stage may include technology development, market studies, business plan preparation and recruiting. If the company is successful at this stage, start-up funds are raised. If unsuccessful, the company closes.

"About 85 percent of the companies make it out of this stage," Turki says.

II. Start-up -- development of proposed product. Here, the company begins shipping a working product. If the product isn't complete or doesn't work, the company is likely to close.

Turki says almost all the companies that make it this far will progress to the next stage.

"Almost 97 percent of the companies at this stage will move on," he says. "That means very few companies -- only about 3 percent -- fail to develop their initial product."

III. Early marketing -- attempt to achieve profitability with first product and prepare for additional product offerings. A successful company achieves profitability, while an unsuccessful one teeters on the edge. Here's where the waters get rough, Turki says.

"Companies in the early marketing stage have only about a 60 percent chance of breaking even, expanding the business and creating new products," he says.

IV. Early expansion -- attempt to grow rapidly beyond break-even. Success at this stage means the company grows beyond twice its break-even volume and is increasingly profitable. Follow-up products approach profitability. If not successful here, sales don't go much beyond break-even and the company loses its initial market share. Turki says once a company reaches the break-even point, it has a 77 percent chance of doubling its sales soon thereafter.

V. Follow-on success -- continued growth, survival of shakeout period and introduction of additional new products. This stage may endure for a long time. The company starts to mature, showing slow growth, and year-to-year profits may occasionally show decreases.

"About 60 percent of the companies succeed in stage V," Turki says.

According to study results, a company's chances of getting through all five stages unscathed are better than one might expect.

"A seed-stage company, based on our sample, has about a 25 percent chance of having uninterrupted success during its early years," Turki says.

However, most companies encounter trouble at some point, hurting their chance of survival, he adds.

"Companies that encounter some sort of failure in stage III, IV or V will move into a redirection stage where they will attempt to turn things around and right the ship," he says. "Once a company encounters some sort of failure -- and almost all will -- its chance of ultimate success falls to around 50 percent. Some companies can endure a major turnaround and become very profitable. But many never bounce back."

Sources: Lassaad A. Turki, (415) 233-3790; Internet, turki@mgmt.purdue.edu
Robert H. Keeley, (719) 593-3674
Writer: Victor B. Herr, (765) 494-2077; Internet, victor_herr@purdue.edu
Purdue News Service: (765) 494-2096; e-mail, purduenews@purdue.edu

NOTE TO JOURNALISTS: A copy of the journal article is available from Lassaad A. Turki, (415) 233-3790. To receive this news release via e-mail, send an e-mail message that says "send punews 9506bp1" to: almanac@ecn.purdue.edu. Purdue News Service also maintains a searchable data base of faculty experts and posts news releases on a web server at http://www.purdue.edu/uns and a gopher server at newsgopher.uns.purdue.edu. The web site also offers selected downloadable photographs.


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